Educational Articles

Coverage Initiation: AOL, Inc.

Michael Napoli, CFA
| October 02, 2010

AOL (AOL) has recently made its debut in The Value Line Investment Survey. The popular Internet company generates advertising revenue through the sale of display, search, and contextual ads. It also generates revenue with its subscription access service, and through the sale of ads on third-party Web sites and digital devices. The company competes with other Internet-information providers, such as Google (GOOG), Yahoo (YHOO), and Baidu (BIDU).

AOL, formerly known as America Online, was originally founded in 1983. The company merged with Time Warner (TWX) in 2001. In the fourth quarter of 2009, Time Warner’s board approved the separation of AOL from Time Warner. The spin-off occurred in December of 2009, and AOL stock began trading on the New York Stock Exchange at that time.

The company has reported unimpressive results for the first and second quarters. Display advertising has declined, on a year-over-year basis. Moreover, a reduction in the number of subscribers has resulted in lower subscription revenue. On the bright side, monthly average churn appears to be improving. Even so, weakness will likely persist going forward, and we anticipate unfavorable results for full-year 2010.

Performance may well improve in the coming years, however. AOL is trying to reposition itself as an Internet growth company. A large part of its strategy is to provide content to growing Internet platforms across the globe. The company is also focused on developing ways to better connect advertisers with a consumer base that continues to adopt digital services at a faster and faster pace. Meanwhile, efforts to improve product offerings and restructure operations should also bear fruit going forward. AOL has reorganized its content unit, relaunched MapQuest, and migrated most of its email users to an improved back-end system. The company has also been divesting non-core assets. It sold ICQ (a leading instant messaging service in Russia and other international markets) to Digital Sky Technologies for $187.5 million. It has also completed the sale of substantially all the assets of Bebo. In addition, AOL has agreed to sell its investment in Kayak Software Corporation for $18.9 million. These moves have improved the company’s financial position and should allow management to increase its focus on core operations.

AOL has recently announced a five-year renewal and expansion of its global partnership with Google. As part of the deal, Google provides search services to AOL’s content network and properties in exchange for a revenue-sharing agreement between the two companies. In addition, Google will provide best-in-class ad formats. This alliance will also cover mobile search, and the companies have agreed to a content partnership that will bring AOL’s video content to YouTube, too.

All told, we find AOL’s efforts to turn its business around fairly encouraging. Nevertheless, it remains unclear how well these initiatives will be received by the marketplace in the coming years. Moreover, our view of the future remains clouded, given the dynamic nature of the Internet industry. The company has yet to demonstrate a track record of sustained growth in revenues and share earnings.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.